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Nike Case Study

1027 words - 5 pages

NIKE INC. Cost of capital estimation

| GROUP
FINN- 400 |

NIKE INC. Cost of capital estimation

| GROUP
FINN- 400 |

Background:

The case is built around the stock buy decision of Nike Incorporation by the North-Point Large Cap fund. The mutual fund manager, Kimi Ford is evaluating Nike’s financial performance. Nike’s revenues had stabilized at $9 Billion since 1997 and Net Income had fallen from $800 Million to about $580 Million. In sum, Nike was experiencing a decline in sales growth, profits as well as its market share in US.

In a meeting in 2001, the management sought to increase its market exposure in the mid-priced footwear and apparel lines ...view middle of the document...

• Estimation of WACC:

The WACC which is the minimum return required by the investor is computes as follows:

WACC = Kd(1-tc) X D/(D+E) + Ke X E/(D+E)

The WACC estimation requires the calculation of
• Market value of Debt
• Market Value of Equity
• Cost of Debt (Kd)
• Cost of Equity (Ke)

Market value of debt and equity is calculated by the market information available and the cost of equity is calculated via CAPM. The cost of debt is calculated by the Nike’s interest expense.

Analysis:

1. Single Vs Multiple Costs of Capital:

The problem arises that whether the analysts should use a single cost of capital for different product lines of Nike or different costs of capital because the risks of different product lines may be different. The approach that we used uses a single cost of capital “The WACC” because the goal is to value the entire firm and all of the division and product lines of Nike have similar type of business risk inherent in them as the business is similar in nature i.e production of footwear.

2. Cost of Debt:

Cohen has used the historical data from the balance sheet of Nike in estimating the cost of debt however the estimation of cost of debt should be forward looking rather than relying on past trends. Therefore, we have used the Yield to Maturity on a 25-Year bond to estimate the cost of debt. The after tax Costs of Debt estimated was about 4.439% as opposed to 4.3% as estimated by Cohen.

3. Cost of Equity:

CAPM is used to estimate the cost of Equity since it is an approach that is more market related than other methods such as Dividend Discount Model.

CAPM’s formula: Ke = Rf + B (Rm-Rf)

•For this, the Risk free rate (Rf) was calculated from the yield on 20-year US treasuries.

•For Beta (B) the most recent beta was used as opposed to an average of past Betas because the most recent beta measure the systematic risk of the businesses in the current and future periods better than by simply using an average of past betas.

• For the market risk premium (Rm-Rf) the geometric mean of the Premium of Market over treasury bonds is used. The geometric mean is used in...

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